Debt Concerns Spiraling Negative Ratings 

Nume Ekeghe writes on the recent downgrade in ratings by both Moody’s and Standard & Poor’s and its effect on the perception of Nigeria to international investors 

Nigeria’s prospects of raising funds at the international market were further dampened recently with the latest ratings by international rating agencies. Moody’s Investors Service had downgraded the sovereign ratings of the country while S&P had reviewed its outlook of the country to negative.

The two rating agencies were concerned about the rising level of Nigeria’s debt and the country’s ability to continue to meet its debt obligations in the future.  Moody’s had downgraded government’s long-term foreign currency and local-currency issuer ratings, as well as its foreign currency senior unsecured debt ratings from B3 to Caa1, and changed the country’s outlook to stable. 

The latest rating by the agency comes just three months after the rating agency downgraded the country’s credit rating to ‘B3’ on 21 October 2022 primarily due to the significant deterioration in the country’s fiscal and external position, exerting increasing pressure on the sovereign credit profile despite a substantial increase in international crude oil prices in 2022.

Implication  

Accordingly, the ‘Caa1’ rating which is judged to be of poor standing and subject to very high credit risk, reflects a downgrade of the country to speculative or non-investment grade. Overall, the ‘Caa1’ rating is the lowest Nigeria has attained since 2006 (when rating agencies commenced coverage of Nigeria) and places the country under the same rating category as Gabon, Iraq, Pakistan, and Tunisia. In relation to its African peers, Nigeria’s currency rating of Caa1 compares with that of Angola, Mauritius, and Tunisia of B3, Baa3, and Caa2 respectively.  

According to Moody’s, the rating downgrade is mainly driven by expectations that the government’s fiscal and debt position would continue to deteriorate. Expressly, Moody’s stated that the review for downgrade focused on Nigeria’s fiscal and external position and the capacity of the government to address the ongoing deterioration – other than by alleviating the burden of its debt through any form of default, including debt exchanges or buy-backs. Moody’s noted that the government’s capacity to respond to the wide-ranging fiscal pressures it faces remains constrained by the country’s long-standing institutional weaknesses and social challenges.  Nonetheless, Moody’s noted that immediate default risk is low, “provided that no sudden or unexpected events (such as another shock or shift in policy direction) would raise the default risk. Thus, the rating agency gave Nigeria a stable outlook.”

On external funding, Moody’s noted that the current constraints come at a time the government’s foreign currency debt service is contained, limiting immediate liquidity risks. However, over the medium term, Moody’s highlighted that the external liquidity profile will likely erode unless the government can improve its access to external borrowing sources. 

This, in turn, will rely on the ability of the government to demonstrate a track record of delivering on fiscal reforms. Overall, Moody’s noted that the trifecta of a brightening oil production outlook, indications that subsidy reform is being implemented, and non-oil revenue improving faster than nominal GDP would signal that the fiscal deterioration is reversing course. 

The agency forecasts that Nigeria’s debt service payments will take up almost 50 per cent of the government’s revenue in the medium term, up from an estimated proportion of 35 per cent in 2022. It also expects the country’s aggregate debt-to-GDP ratio to rise to  about 45 per cent in 2023. This compares with 34 per cent in 2022 and 19 per cent in 2019. The agency expressed renewed optimism about the recovery path of Nigeria’s economy under a new administration after the forthcoming general election.

Similarly, Standard & Poor’s (S&P) on Friday last week affirmed Nigeria’s credit rating at B-/B, making no changes from its previous ranking but highlighting risks to Nigeria’s servicing capacity in the long term and revising the outlook downward to “negative” from “stable.”

S&P in its latest rating cited increasing risks to the country’s debt servicing capacity over the next one-to-two years, as it said, “Nigeria’s debt servicing capacity has weakened due to high fiscal deficits and increased external pressures.

“Ultimately, the risk that a negative feedback loop sets in over the next couple of years between higher government borrowing needs and rising interest rates have intensified, exacerbating the policy trade-off between servicing debt and financing other key spending items”. It noted that 2023 budget plan is laced with an even larger fiscal deficit than in 2022, while the government’s funding options remain narrow and reliant on central bank financing. In addition, it stated that the government’s lack of access to external funding sources would add to the external pressure from depressed oil production and capital outflows, thereby eroding further Nigeria’s external profile over time.

The common ground for both the Moody’s and S&P reports is the concern for Nigeria’s liquidity in the long term. On liquidity metrics, the ratio of debt service to revenue is approximately 80.7 per cent in November 2022, higher than the 25 per cent adopted by the DMO as outlined by the International Monetary Fund and World Bank debt sustainability metrics. Similarly, external debt service to oil revenue stood at 184.8 per cent in November 2022, while Nigeria’s total debt to GDP and revenue to GDP stood at 35.2 per cent and 3.8 per cent, respectively, for the same period.

Reactions

As a result of the ratings, investors had become jittery as concerns about Nigeria’s debt servicing capacity intensified. This was evident as Nigeria’s dollar-denominated government bonds depreciated ahead of the ratings report. These events are critical factors that would impede Nigeria’s access to financing in the international debt market.

According to analysts at Cordros Research, the risk that a negative feedback loop sets in over the next few years between higher government borrowing needs and rising interest rates has intensified, worsening the policy trade-off between servicing debt and financing other essential spending. 

Also, analysts at FBNQuest noted that the downgrade has significant implications, including challenges in raising commercial debt from external sources, higher pricing of the country’s debt on the international capital market, difficulty in attracting foreign capital, and potential capital flow reversals.

Cordros analysts said they expect investors to be cautious of Nigeria’s Eurobonds, pending the outcome of the February general election, adding, “We think the recent rating downgrade will add a further layer of pressure on prices in the near term, more so that this is the first time since Nigeria has been downgraded to Caa1. 

 “Downgrading the country’s credit rating further into a speculative grade implies that investing in Nigeria’s sovereign bonds is considered riskier, and the probability of default has increased compared to when the rating was at ‘B3’. Accordingly, another likely implication of the downgrade is that Nigeria will find it difficult to access the foreign currency debt market in the short-to-medium term as investors price in the risk of default into the cost of debt amid the lingering increase in global interest rates. 

 “Based on the preceding, the government’s options for funding annual budgets will be limited, with most of the funding need to be channeled to the domestic debt market, as we have seen in the 2023 budget. Barring the continued utilisation of the CBN’s Ways & Means advances, we expect domestic fixed-income yields to rise significantly to drive participation by local market players. 

“Finally, the negative sentiments from the rating downgrade are also expected to further worsen the country’s already low foreign direct investments, implying a further decline in foreign capital inflows. Pertinently, some academic studies on Africa found that there is a statistically significant relationship between FDI and sovereign credit rating. 

“Thus, other things being equal, global investors prefer investing in countries with good credit ratings as they perceive it as a good measure of risk allocation. Besides, a rating downgrade increases the cost of debt, limiting the government’s ability to embark on efficient capital-forming initiatives. Accordingly, we believe foreign investors will be on the lookout for the February general elections and policy direction afterwards.”

In the medium term the analysts say they believe Nigeria is unlikely to default in the near term. 

“We think continued expenditure expansion with little revenue growth would steepen the path towards a debt default. Consequently, the 2023 general election represents the most significant event that could provide further insights into Nigeria’s likely fiscal path over the short-to-medium term,” the analysts said.

Going Forward

Going forward, these negative ratings is a call for the government to reassess policies that should be implemented to tackle the fiscal challenges. On the revenue side, ending subsidy payments on PMS and restructuring the oil sector to improve output levels should be initial considerations. This will be a steppingstone to ending the ways & means for deficit financing. 

The government, through its agencies, will also need to improve monetary policy communications and ensure market-reflective structures that are attractive to foreign players. Also, there is a need to cut down on non-essential recurrent expenditures and institute a more suitable budgeting approach.